Industrial Ecology and “Getting the Prices Right”

Industrial Ecology and
“Getting the Prices Right”
by Allen V. Kneese
Industrial ecologists are employing innovative technologies and other inducements to curb environmental degradation. Fixing the markets could accelerate—and simplify—progress toward their goal.
uring the 1990s, the term “industrial ecology” has
emerged from academia into corporate and public
The term reflects a conviction that modern
industrial activity must account for its environmental
impacts (see Jesse Ausubel’s story on page 14). Some
nations and firms are paying serious attention to the
ultimate goal of industrial ecology, which is to minimize harmful wastes and to use and reuse to the greatest extent both industrial products themselves and their
wastes. As yet, though, such interest is very isolated.
Why is interest not more widespread in achieving
the benefits seen by industrial ecologists? To an economist, the question is why markets are failing to incorporate on their own the objectives of industrial
ecology. The answer is that markets need to be fundamentally restructured so that prices reflect the full
social costs of production. Reconfigured markets,
combined with proper incentives such as emissions
and effluent fees, could persuade more firms to act in
environmentally beneficial ways. To achieve this fix,
however, policymakers—particularly in the United
States—would have to abandon their impulse for
central planning and direct regulation.
The Roots of Industrial Ecology
Like all serious ideas, industrial ecology has origins in
earlier work. Much of this research took place at RFF
in the 1960s and 1970s, where early work in environmental economics supported the development of
integrated policies and practices in environmental and
natural resources management. One research topic
being addressed here at that time was residuals management in specific industries and regions. That is,
RFF researchers were examining economic activity
based primarily on a simple fact: the sum-total of
materials and energy flowing through the economy
must be accounted for, either as part of a process,
product, or service, or as “leftovers.” Residuals—waste
materials and the energy not fully used in either production or consumption—must go somewhere,
according to the first (materials balance) law of thermodynamics. They can simply be returned to the
environment in the water, land, or air; alternatively,
wastes from one plant or industry can become the
material or energy resources for other processes,
plants, or industries. Environmental pollution illustrates the former; the well-known “ecoindustrial”
complex in Kalundborg, Denmark is one example of
the latter.
Why does industry fail to incorporate recovery and
recycling practices more routinely into its operations?
In large part, business practices, the laws and regulations that govern them, and the markets in which they
operate, all conform to conventional economic conceptions of production and consumption processes.
Unfortunately, economists have by and large ignored
the important flows of materials through the economy
and the physical laws governing them. Goods and
services in the marketplace are made out of something, but classical models generally fail to consider
where that something comes from and where it goes.
(Even the term consumption as commonly used by
economists is apt to be misleading, since what in fact
is consumed in market transactions is not a physical
mass but a flow of services from that physical mass
that are involved in production and consumption.)
Kemira acid plant
Lake TissØ
Waste heat
Statoil refinery
Cooling and
waste utility
Treated sludge
for fertilizer
District heating
Neighboring farms
Waste heat
Asnaes power station
Waste heat
Novo Nordisk
pharmaceutical plant
Fly ash
Gyproc wallboard
Fish farms
Cement and road
The industrial ecosystem at Kalundborg, Denmark
Working at Resources for the Future, Robert Ayres,
Ralph d’Arge, and I borrowed the ideas of mass conservation and materials balance from the physical
sciences in order to model and analyze the flows of
materials through the economy. While the model that
resulted is somewhat technical, its basic ideas are
simple: the environment can be viewed as a large shell
(see page 12 illustration) surrounding the economic
system, providing sustenance and carrying away
wastes. Broadly stated, the mass of residuals returned
to the natural environment must be equal to the mass
of basic fuels, food, minerals, and other raw materials
entering the processing and production system, plus
atmospheric gases. This principle must hold true for
each sector of the economy taken separately and for
economic systems taken as a whole.
Resource use, production, and consumption, seen
from this perspective, could be aptly described as
processes of materials and energy throughput and
balanced materials flows. More importantly, these
processes are intimately bound together with the
problems of residuals disposal, and hence with the
pollution of air, land, and water that occurs when the
capability of the environment to absorb and assimilate
the returning materials is overwhelmed. Considering
problems of air, water, and solid waste in isolation
from each other is thus insupportable, even though
our laws and regulations, then as now, treat each
environmental medium separately and as the locus of
largely isolated problems.
The powerful incentives and price-setting effects of
markets now operate in the economy for natural
resources (such as oil, minerals, and agricultural land)
that serve as commodities. In contrast, markets exist
only highly imperfectly or not at all for the environmental resources to which most residuals are usually
returned, such as regional or global airsheds and
watercourses. Instead, these are seen as “common
property” that falls outside normal market exchange.
Thus their price is effectively set as zero. Such
resources tend to be used for the disposal of residuals
as though for other purposes they are valueless.
Unfortunately, laws meant to control such use rely
upon efforts to regulate their use directly, not to correct the faulty price signals given by the market concerning the use of common property resources. Thus
they are fighting the price system rather than working
with it.
(with an amended version of the model) examined
how incentive (pricing) approaches can be made to
yield such desired results as meeting regional environmental standards at the least cost to the region.
Implications for Policymaking
These early RFF studies are of more than archival
interest; in the intervening years, policies based on
command and control have changed hardly at all. A
Applying the Research
number of other countries regard environmental
Research at RFF evolved over time toward establishing
degradation to result largely from a failure in the sysquantitative estimates for relationships that the theotem of economic incentives, much as I have argued
retical work suggested might be important. Robert
here, and attempt to remedy it through emissions fees
Ayres went on from RFF to continue this work, helppolicies (more popularly referred to as “green taxes”).
ing it to grow into a discipline now widely known as
The United States, however, continues with a policy
industrial metabolism. (A significant underpinning of
approach that is fragmented and grossly overdepenindustrial ecology, industrial metabolism can be
dent on direct regulation rather than one that attempts
defined as the integrated set of all
to modify the defective system of
The Environment
physical processes that
economic incentives. A new
convert raw materials,
policy departure could
energy, and labor
benefit from the
The Economy
into products
RFF models.
and waste
While these
Final Product
Material Inputs
studies have
been highly
within RFF
on residuals
useful as
research tools,
yielding a number of
continued along two
significant insights, they are
main lines. Clifford
not routinely modified, mainRussell, William Vaughan, Blair
Bower, and others focused on the
tained, and updated broadly for the
Materials balance and the economy
individual plant level, examining
regions across the country.
materials balances and flows and how they related to
Such systematic attention would be required for
prices, including both prices for “normal” inputs and
these models to support rigorously justifiable pricing
outputs and (experimentally) for residuals discharges
systems for environmental resources. But the gains
(services of common property resources or emissions
thought to be achievable through industrial ecology
fees). Quantitative studies examined the petroleum
could not in any case be reaped through central planand steel industries, among others, embodying materining and direct regulation. The futility, or worse, of
als balance concepts and other innovative procedures.
this approach is revealed in the disastrous results it has
A second line of RFF research applied these ideas
produced in economies all across the world where it
on a regional basis, specifically to the heavily industrihas been tried as a tool of industrial development and
alized and populated lower Delaware River valley.
management. In contrast, correcting the pricing sysBower, Russell, and Walter Spofford developed an
tems may reveal the apparent gains touted by industrienvironmental quality model accounting for materials
al ecology to be little more than artifacts of a distorted
flows and balances to test the significant linkages,
system of economic incentives.
including costs, among the management of different
An alternative policy approach that allows for more
types of residuals in a regional context. Later studies
flexible, decentralized, and dynamic adjustments
invites serious consideration. A plan to “get the prices
right” by correcting incentives currently distorted by
the price system and misguided public policies should
proceed on two fronts, involving subsidies and fees.
Subsidies—First, the subsidies that have historically
been built into our economic system to aid rapid and
large-scale exploitation of natural resources ought to
be re-examined. They have encouraged excessive use
of materials in general and attached false economic
advantages to the use of virgin rather than recycled
materials. These incentives reinforce the failure to
price common-property resources by increasing
throughput of materials and energy in the economy.
Removing them will mean higher prices (for energy,
for example), but these changes should be carefully
distinguished from inflationary increases. They reflect
the embedding in prices of the newly unsubsidized
costs of particular goods and services.
One means for adjusting these incentives would be
to scrutinize depletion allowances and other tax policies that favor more rapid exploitation of natural
resources. Producers of most mineral and energy products, such as petroleum, lead, zinc, copper, and bauxite, receive special treatment that effectively reduces
their tax rates. This practice keeps their prices lower
than they would otherwise be, and thus encourages the
use of virgin materials vis à vis recycled ones. Other
examples are the remaining agricultural subsidies
embedded in our farm policies and the extremely low
prices for government-supplied water in the arid west.
Such subsidies, while often entirely inappropriate to
current circumstances, are so embedded in our overall
economic system that phasing them out might in given
cases require some form of adjustment assistance.
Fees—A second policy initiative to combat perverse
incentives would involve directly and systematically
encouraging the conservation of environmental (common property) media through the use of effluent and
emissions fees—“green taxes.” Creating and maintaining a fully coherent, organized set of effluent taxes
based on economic modeling analyses is not possible
at this time due to excessive information requirements.
However, levying such taxes across a broad front of
activities that affect common property resources would
recognize the interdependencies among environmental
media and provide incentives for continuing development of processes that consume fewer materials or that
are more conducive to recycling or treatment of residual materials.
America’s legal and regulatory systems address issues
related to resource conservation and environmental
improvement almost entirely through direct regulation
of particular environmental media. Such an orientation
continues to produce the familiar field days for
lawyers, heavy costs, a huge bureaucracy, ad-hoc and
capricious impacts, and far-reaching intrusion by
government into decisions about the design of industrial processes.
An incentive-oriented (emissions fee) approach
could not by itself deal with all of the sticky problems
that arise in achieving environmental management
objectives. For example, the discharge of highly toxic
or persistent substances might still have to be prohibited by law and prevented through regulation.
Schedules of effluent and emissions taxes that truly
minimized the costs of achieving pollution control
objectives would be too complex for practical application, and the necessarily more simplified schedules
would inevitably introduce some inefficiencies into the
The advantage that can be claimed for the incentives approach, therefore, is not that it is free of
administrative problems, for it is not. Nor can it fully
replicate a theoretical least-cost solution in achieving
environmental objectives, such as that yielded in
principle by the Delaware study. An incentives-based
policy would, however, be based upon a sound conception—that prices should reflect all costs—and
upon experience that shows the tremendous power of
prices and markets as signals to improve the allocation
of natural resources.
Allen V. Kneese is a senior fellow and resident consultant in the Quality of the
Environment Division.